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The Only Bonds Worth Buying

I'm referring to emerging-market bonds, which have been roughed up, if not brutalized, over the past month.

To me, that's good news. I'm instinctively attracted to investments going through a rough patch, as mass fear and disdain frequently lead to the best values. (In fact, the July edition of High Yield Wealth features a master at investing in the feared and the disdained.)

Therefore, my interest was piqued last week when I read about the mass exodus from emerging-market bonds. EPFR Global, a firm that tracks fund flows and asset allocations, reported emerging-markets debt funds experienced $5.58 billion in net outflows for the week ended June 26.

This is the largest recorded outflow EPFR has ever recorded. According to Morgan Stanley's Robert Habib, the outflow amounts to a third of the net inflows into emerging-market debt funds year to date.

So what's going on?

Unrest is an issue in one of the more popular emerging markets - Brazil. Protesters are clamoring for more socialism, which is never a good thing. And the government is showing some willingness to capitulate, an even worse thing.

Turkey, another popular destination for U.S. dollars seeking yield, is also experiencing civil unrest.

For most everyone else, though, weaker growth is the issue. China, India, Indonesia, Mexico, Russia, Poland, Chile and Peru are all expected to grow at a slower pace in 2013 compared to 2012.

The recent rally in the dollar, brought about by rumors of Federal Reserve tapering and rising interest rates, makes foreign debt priced in the local currency less attractive. On the other side of the coin, foreign debt priced in U.S. dollars can become more expensive for the locals to service.

There is plenty of bad news, which points to plenty of opportunity. Prices are down and yields are up on many popular emerging-market bond funds.

So I'm taking a closer look.

WisdomTree Emerging Markets Local Debt Fund (ELD) , a fund that invests in sovereign debt denominated in the local currency, is down 11% over the past six weeks, and hit an all-time low last week.

Much of ELD’s portfolio is allocated to the sovereign debt in the countries I mention. It's worth noting, though, that more than half the debt in the portfolio, 54%, is rated “A” or higher.

WisdomTree focuses on quality and yields 3.8% annually

Market Vectors Emerging Markets Local ETF (EMLC) has also popped up on my radar. Market Vectors, like WisdomTree, invests mostly in the sovereign debt of the aforementioned countries. The difference is that Market Vectors ventures out on the risk curve; only 21% of its portfolio is rated “A” or higher.

But more risk means more return. Market Vectors' latest distribution, which was raised with the most recent payment, produces a 5.4% yield.

This emerging market bond fund is down 13%, which has pushed the yield up to 4.5%. The fund has a different weighting compared to WisdomTree and Market Vectors, with a heavier weighting on out-of-the-way locales like Sri Lanka, Lithuania and Croatia.

The fact this fund invests in debt denominated in U.S. dollars is particularly intriguing, because if the Fed actually starts to taper and interest rates start to rise, the U.S. dollar will continue to appreciate. And that gives this fund an advantage over those funds that own debt denominated in the local currency.

All three of these funds have something to offer, and all three have more to offer after the recent sell-off.